Crude oil market likely to turn choppy on Hurricane Harvey

This has been the biggest deterrent to oil price rallies as it slows down the market rebalancing process.By Harshal BarotCrude oil closed lower for a fourth consecutive week, but prices are still stuck in a broader range over the past couple of months. Trading this week may be choppy as markets assess the impact of the Hurricane Harvey on US energy infrastructure.

US oil rig count fell again last week which helped prices up. US inventories continued to decline but oil production edged up once again. Libya’s oil output remains volatile and vulnerable to disruptions.

Two more oil fields in Libya are being closed after an armed group took over pipelines. Opec compliance faltered in July but the Opec meeting in Abu Dhabi raised hopes of better compliance in August and September.

Looking ahead, the short term bias for oil remains positive but this week’s action will be dictated by the impact of Hurricane Harvey on US energy infrastructure.

The near term action in oil prices will depend on the impact of Hurricane Harvey. The hurricane forced refineries across the US Gulf Coast to shut down impacting nearly 2.2 mbpd of refining capacity.

The immediate impact on crude could be negative as this means lower demand for crude oil from refineries. US oil exports will also be impacted which could translate to higher inventories this week.

Product prices will however be supported shutdown in refineries will reduce production. Gasoline prices in the US have touched a two-year high. On the other hand, close to 0.68 million bpd of US oil output is likely impacted which will support oil prices eventually.

We could also see a reduction in number of oil and gas rigs in the coming weeks which will further be price supportive.The impact of Hurricane notwithstanding, the oil market has turned extremely choppy in the recent days and prices have failed to move out their range despite a host of triggers in the recent weeks. At the start of this month, the Opec meeting raised hopes of better compliance with Saudi indicating more export cuts in September as well.

Earlier, Saudi suggested that it will export 6.6 mbpd in August, down from 7.1 mbpd in July. Iraq has also hinted about better compliance and it will be crucial to see if it follows through given that Iraq has been of the worst in compliance so far.

If we see actual steps towards improving compliance, it will help dispel concerns about the Opec deal falling apart and will help prices move up more convincingly.

The IEA and Opec reports were largely supportive of oil prices. Primary among the list was the revision in demand forecasts. Global demand remains healthy this year and forecast was revised higher by 0.1 mbpd by both.

The Opec now sees demand growth of 1.4 mbpd this year while IEA sees growth at 1.5 mbpd. Demand remains robust, especially in top consumers India and China. US gasoline demand remains near a record 9.8 million bpd.

Refining margins have been improving which is likely to keep refinery processing high before the maintenance season begins in September. Refineries in the US were processing a record 17.5 mbpd of crude before the Hurricane hit.

Looking at supply side fundamentals, Opec output rose by 173,000 bpd in July to 32.87 million bpd on the back of increased output from Libya and Nigeria. Consequently, Opec’s exports rose to a record high in July, touching 26.11 mbpd.

The rise was largely due to Nigeria, whose exports jumped by 260,000 bpd. Saudi’s oil exports have averaged 7.26 million bpd in the first seven months of 2017, down 0.3 mbpd from the 2016 average.

Overall, the rebalancing process remains slow and resumption in Nigerian and Libyan output has complicated the Opec strategy. Nigerian production is back at a 17 month high of 1.8 mbpd while Libyan output has nearly tripled from last year with production nearing 1.0 mbpd.

This roughly translates to an increase of about 0.4-0.5 mbpd from these two and negates nearly half of the Opec’s 1.2 mbpd cut. Opec data indicate compliance of 86 per cent in July but IEA suggested that Opec's compliance with the cuts had fallen to 75 per cent, the lowest since the cuts began in January.

This has been the biggest deterrent to oil price rallies as it slows down the market rebalancing process.

US oil production also continues to edge higher and weekly data from EIA shows that total US oil production is close to 9.53 million bpd, the highest since June 2015. EIA forecasts show that US shale oil production is expected to rise further and touch a record high in September.

The EIA drilling productivity report shows that shale oil output will likely touch 6.1 mbpd in August. The EIA also forecasts total oil output to reach a new record and surpass 9.9 mbpd next year. This is going to remain the biggest head-wind for oil prices.

On the inventory side, EIA data showed that US oil inventories fell by 3.3 million barrels last week and total stocks have declined by 72 million barrels since the end of March. US oil inventories are back within the five-year range and are at their lowest since January 2016.

Gasoline stocks fell by 1.2 million to 229.9 million barrels while distillate stocks were up 0.7 million last week. In Europe, ARA product stocks were up 1.3 per cent w/w but 6.3 per cent lower y/y at 41.4 million barrels.

In July, OECD stocks declined by 19 million barrels to 3.02 billion barrels but stocks remain 219 million barrels above the 5-year average. A more meaningful reduction in global inventories will be imperative for establishing a firm floor for oil prices.

Looking ahead, the short term price action is likely to remain choppy. Technically, MCX Crude oil price consolidated in a narrow range between Rs 3010-3120 levels last week, closing lower by about 1.5 per cent for the period.

The price however managed to hold above strong short-term support at Rs.2950-2935 zone. Looking ahead, a brief dip towards this support area looks possible. However, the same could be used as a buying opportunity as the medium-term bias still looks positive. Test of higher resistance at Rs.3240-3260 zone could be seen eventually.

(Harshal Barot is a Commodities Analyst at Motilal Oswal Commodities Brokers. Views expressed in this article are author's own and do not represent those of ETMarkets.com)

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